He Wall Street Journal reports that the rate on three-year Treasury securities is 4.75 percent and the rate on four-year Treasury securities is 5.00 percent. The one-year interest rate expected in three years is E (4r1), 5.25 percent. According to the liquidity premium theory, what is the liquidity premium on the four-year Treasury security, L4?

0.0375 percent

0.504 percent

5.01 percent

5.04 percent

Question

Business

Shyla

11 May, 20:45

He Wall Street Journal reports that the rate on three-year Treasury securities is 4.75 percent and the rate on four-year Treasury securities is 5.00 percent. The one-year interest rate expected in three years is E (4r1), 5.25 percent. According to the liquidity premium theory, what is the liquidity premium on the four-year Treasury security, L4?

0.0375 percent

0.504 percent

5.01 percent

5.04 percent

+5

Answers (1)

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Anderson · Answer 1

1 + 1R4 = { (1 + 1R3) (1 + E (4r1) + L4) }1/4

1.0500 = { (1.0475) ^3 (1 + 0.0525 + L4) }1/4

(1.0500) ^4 = (1.0475) 3^ (1 + 0.0525 + L4)

(1.0500) ^4 / (1.0475) ^3 = 1 + 0.0525 + L4

(1.0500) 4 / (1.0475) ^3-1.0525

L4=.0050358564 = 0.504%